I am trying to assist a couple with their personal finance and investing. There are some hurdles to get over before this will probably be relevant but the goal would be to have this worked out to be in effect for 2018.

I have not done this level of analysis before so this is a good test for me but want to make sure my reasoning is sound.

My goal for them would be to invest heavily to get them down to the 15% tax bracket ($18,551 - $75,300) which could be done through tax advantaged accounts.

1. Investing in their TSP (or other tax advantaged account) by at least $28,740 annually this would essentially put them in the lower tax bracket. Is this an accurate assessment?

2. Is there a reason that this should not be a goal? To me this would save them almost $18,000 annually in taxes. It would also mean that the government is funding that much towards their investments annually.

Thank you for your assistance.

EDIT

Thank you all for the comments and the references. I have some research to do. For those that stated that I lack the understanding of how taxes work are absolutely correct. My numbers came from simple math with my misunderstanding that if you fall into a bracket then that is your tax rate for all of your income. This new knowledge will assist in my retirement planning as well.

I will also put their information into a tax program to see the effect different adjustments will have on their income. One of them will be receiving a $1000 monthly pay raise next year so taking this information will help with that life change as well.

Last edited by retirementbound on Tue Nov 29, 2016 9:01 pm, edited 2 times in total.

retirementbound wrote:I am trying to assist a couple with their personal finance and investing. There are some hurdles to get over before this will probably be relevant but the goal would be to have this worked out to be in effect for 2018.

I have not done this level of analysis before so this is a good test for me but want to make sure my reasoning is sound.

My goal for them would be to invest heavily to get them down to the 15% tax bracket ($18,551 - $75,300) which could be done through tax advantaged accounts.

1. Investing in their TSP (or other tax advantaged account) by at least $28,740 annually this would essentially put them in the lower tax bracket. Is this an accurate assessment?

2. Is there a reason that this should not be a goal? To me this would save them almost $18,000 annually in taxes. It would also mean that the government is funding that much towards their investments annually.

Thank you for your assistance.

It's not clear if you are considering the fact that the "higher" tax rate is only on the income above the lower bracket.

This is the distinction between "marginal" and "effective" tax rates.

That is, for example, if one is over a rate change point by, say, $100, then ONLY that "next $100" is taxed at the higher rate.

(Sorry if I've misunderstood.)

Edit to add: A look at the IRS tax tables (not just a list of the different rates) should help make this clear.

If they are in the 25% tax bracket their average tax rate will not be 25% - it should be a lot lower. A tax software program or taxcaster (online) should get you a reasonable estimate. If they live in a state with income tax, you would have to add that.

When you discover that you are riding a dead horse, the best strategy is to dismount.

Make sure you understand how tax brackets work. Only incremental income is taxed at the higher brackets. The numbers in your example seem wrong... one does not pay 29K in taxes on 116K income. Unlikely they can save 18K in fed taxes by putting 28K in their 401k. More likely it would be 7K in savings (tax deferred, really) at 25% bracket.
Also is $116K gross income as opposed to taxable income? Taxable income on form 1040 is after standard deduction and personal exemption.
I don't see the 4K per person personal exemption (16k) subtracted to calculate tax bracket either.
If they have 2 kids, they can probably get child care credit, child tax credit, etc which would bring down their taxes.

Use a free tax software to put in all the relevant info and then do what-if scenarios.

Your heart is clearly in the right place, but your analysis is missing, in my opinion, two big things.

The first is the difference between marginal tax rate (the % you pay on the last dollar earned) vs effective tax rate (the average % paid on all dollars earned). Lots of people misunderstand the difference, so no worries. Others have commented on this above - or you can read this: http://hugocpa.com/the-difference-betwe ... -tax-rates

Second, and maybe even a bigger issue is that this feels like the tail wagging the dog. The tax advantages of a retirement account are neat - there's no denying that. But, let's not lose sight of the biggest benefit of retirement accounts: namely, retirement. If your friend has the ability to be investing an additional $28K per year in retirement accounts, the chances are that they should be doing so - even if it didn't change their tax bracket or taxes paid.

I hope that makes sense, but if not, just reply and we'll figure it out.

My goal for them would be to invest heavily to get them down to the 15% tax bracket ($18,551 - $75,300) which could be done through tax advantaged accounts.

As others have pointed out your tax reasoning looks incorrect. What you showed above seems to indicate that your "taxable income" amount is really their adjusted gross income. Taxable income on line 43 of the 1040 is after deductions and personal exemptions. Plus there may be child tax credits. Suggest you play with a tax forecaster such as HR Block's https://www.hrblock.com/get-answers/tax ... e/aboutYou

If this interpretation is right their tax owed is only about $12,000 not $29,000.
JW

Tal- wrote:Your heart is clearly in the right place, but your analysis is missing, in my opinion, two big things.

The first is the difference between marginal tax rate (the % you pay on the last dollar earned) vs effective tax rate (the average % paid on all dollars earned). Lots of people misunderstand the difference, so no worries. Others have commented on this above - or you can read this: http://hugocpa.com/the-difference-betwe ... -tax-rates

Second, and maybe even a bigger issue is that this feels like the tail wagging the dog. The tax advantages of a retirement account are neat - there's no denying that. But, let's not lose sight of the biggest benefit of retirement accounts: namely, retirement. If your friend has the ability to be investing an additional $28K per year in retirement accounts, the chances are that they should be doing so - even if it didn't change their tax bracket or taxes paid.

I hope that makes sense, but if not, just reply and we'll figure it out.

Thank you for the response. You are correct that my understanding is way off. I was not aware that tax rates were staggered like that. I just thought that if you had a certain income level then you paid taxes at that rate. This will definitely help in planning for my retirement.

In response to your second comment we have just begun the journey of analysis on their situation. This was more me getting ahead on something that intrigued me. I agree that they can get to a point where they are putting that kind of money into their investments. One of them will be receiving a monthly raise of $1000 next year and I want to ensure that that amount will go into their retirement. It will be a journey because it seems that there will be some behavioral/debt issues to overcome.